Nevertheless, at least Rachel Reeves has claimed she will not be “coming back with more taxes”. This should provide people with some relief – if they can believe it.
But this remark comes from the same stable as the earlier declaration that taxes would not be going up for “working people”. And we all know what happened with that one.
Mind you, there is a good deal to be said for a government to get the bad news out of the way early, leaving time and fiscal room to give some goodies away before the next election. But that does not necessarily mean that all the bad news is bound to come in the first Budget. “Early” can stretch across two or three years.
This is what happened under Margaret Thatcher’s first government. The initial Budget in 1979 seemed pretty grim, including a near doubling of VAT from 8pc to 15pc and an increase in base rates from 12pc to 14pc.
But this wasn’t the end of the nasty medicine. Interest rates were increased again in November from 14pc to 17pc and the big tax rises didn’t come until the Budget of 1981 – which famously prompted a letter to The Times newspaper from 365 irate economists (not including yours truly).
Margaret Thatcher’s first Budget in 1979 seemed pretty grim - PA
With only a few weeks having passed since the 2024 Budget, fiscal pressures are already building. For a start, the Budget left little headroom against the Chancellor’s own fiscal rules.
The most important of these is that the “current” Budget (ie. excluding public investment) should be in balance by 2029/30. In the OBR’s assessment, published to coincide with the Budget, the fiscal headroom against this target was wafer thin at just £9.9bn.
To put this into perspective, at fiscal “events” since 2010, chancellors have, on average, had headroom of £27bn against their fiscal mandates.
Moreover, recent financial developments have been adverse, with market expectations of the future level of Bank Rate having edged up and the yield on gilts being slightly higher. If sustained, these market moves would increase the OBR’s forecast for the Government’s annual interest bill by about £3bn, thereby reducing the fiscal headroom to only about £7bn.
Furthermore, as has become customary, the OBR’s Budget numbers assumed that the Government was going to increase fuel duty in line with RPI inflation from 2026. But in the past, this intention has been more honoured in the breach than in the observance.
Since 2011, no chancellor has raised fuel duty. Continuing with this practice would leave the Chancellor with about £5bn less revenue in 2029/30, thereby reducing the fiscal headroom to a mere £2bn which, in relation to total revenue of over £1 trillion, is chickenfeed (less than 0.2pc of the total).
Probably the greatest threat to the fiscal plans is the overall health of the economy. With the disastrous effect of the Budget on confidence and a looming threat to international trade from president-elect Trump, combined with signs of serious economic weakness on the Continent, the economic background is not good.
Any weakness in GDP would tend to increase borrowing as tax receipts fall and expenditure on benefits rises.
Admittedly, what happens to GDP in the immediate future is not directly relevant to meeting the fiscal target in 2029/30. It would be possible for GDP to be weak over the next couple of years but then to recover more strongly than had earlier been forecast, such that nominal GDP in 2029/30 is no lower than the OBR had projected when making its fiscal prognostications.
But this is by no means certain. If the economy turns out to be weak in the next year or two then this will probably have the effect of depressing private investment, which would limit the scope for GDP to bounce back by 2029/30.
Furthermore, higher borrowing in the next few years would, other things equal, increase the amount of government debt and that would imply higher interest payments each year, including in 2029/30.
Then we come to the Government’s spending ambitions. In September the Chancellor said that there would be no return to austerity. Yet under the existing plans, spending by unprotected departments is scheduled to fall by 1.1pc in real terms each year from 2025/26 onwards. Preventing such reductions would cost serious money.
Additionally, the Government has an ambition to increase defence spending from 2pc of GDP to 2.5pc, although it hasn’t yet declared a date for this to be realised. One suspects that events will force its hand.
The Government also nurses an ambition to increase spending on overseas aid from 0.5pc of gross national income to 0.7pc. It is envisaged that this ambition can be realised “as soon as fiscal circumstances allow”. Even if she balances the current budget by 2029/30, would “fiscal circumstances allow” with public debt running at about 100pc of GDP?
The result is that unless something improves significantly by the next fiscal “event”, the Chancellor may have to take further fiscal action. It was reported last week that the next multi-year Spending Review has been postponed until June. Nevertheless, the OBR is scheduled to publish an updated forecast in March.
Of course, whenever it is, the Chancellor could simply amend the fiscal rules or even continue as things stand, with the OBR declaring that she is unlikely to meet them.
Yet this would be reckless. The market would certainly not like this approach and the result would surely be higher gilt yields, which would intensify the fiscal problem.
More likely, she would have to do something to trim government spending or, perish the thought, increase taxes yet again. But, presumably, not on “working people”?
There is likely to be a good deal of humble pie to be eaten.
Roger Bootle is senior independent adviser to Capital Economics and a senior fellow at Policy Exchange. roger.bootle@capitaleconomics.com
